In search of an appropriate tax base for local Leviathans

Abstract

The impact of local fiscal policy depends on the choice of the tax base. In this paper, we take four criteria to evaluate tax bases, namely: efficiency, simplicity, flexibility, and fairness. The results of such an evaluation depend on how we describe the involved agents. We construct a two stage model of a local economy with three types of agents: Leviathans, households, and housing firms. Each Leviathan seeks to maximize the surplus of his local fiscal budget. Each household seeks to maximize its life-time utility from three types of goods: composite private goods, housing, and local public goods. Each housing firm seeks to maximize its profits. In this model, we analyze the characteristics of four distinct tax bases: land rent, housing capital rent, housing sales, and housing property. In particular, we analyze the responses of the households, the housing firms, and the housing prices on a change of a specific tax rate. The results are used to evaluate each tax base with respect to our four criteria.